Tax Advantaged ‘Accountable Plans’ for Employee Business Expenses

Why they can be even more attractive in 2011.

by
Blake Christian, CPA, MBT

Published July 29, 2010

Blake
Christian

Employers encounter numerous issues in reimbursing employees for their business expenses. The employer cost of reviewing the supporting documentation, corresponding with employees and issuing a reimbursement check can be as high as $50 per reimbursement check. Furthermore, even with a detailed employee travel, meals and entertainment policy, numerous “one-off” issues arise regarding which expenses should or should not be reimbursed.

Some employers attempt to bypass all of the detailed expense reimbursement rules contained in Treas. Reg. Section 1.62-2 (PDF) by simply providing employees with a car allowance or other expense allowance, with no requirement to account for the expenditures. Such arrangements are treated as “Non-accountable Plans” under Treas. Reg. Section 1.62-2 (PDF) and such allowances provided to the employees are required to be fully reported on Form W-2 and are subject to all payroll taxes at the company level and to payroll and income taxes at the employee level. Those employers who fail to include these allowances on the employees’ W-2s run significant risk of payroll tax exposure and penalties. Furthermore, the employee is generally limited (due to adjusted gross income (AGI)) on any offsetting deductions they may be able to claim on Form 2106 or Schedule A — a fact they often do not discover until they are filing their tax return the following year, which can generate some tension between employer and employee.

One solution to minimize internal cost accounting and maximize tax efficiency is to adopt an “Accountable Plan” (see Treas. Reg. Section 1.62-2 (PDF) and IRS Publication 463) that can be very beneficial to both the employer and the employee — both administratively and tax-wise.

With the challenging economy for the past two years, employers are cutting back payroll and benefits with resulting morale issues. An Accountable Plan is one way that employers can increase after-tax compensation to the employee while improving the business at the same time. The benefit to the employee is that the properly accounted for reimbursements or allowances are not reportable on the employee’s W-2. At the same time the employer can avoid paying payroll taxes on the reimbursement or allowance.

In order to be classified as an Accountable Plan, Internal Revenue Service (IRS) publication 463 states that the arrangement must include all of the following:

The employee expenses must have a business connection.

The employee must adequately account for the expenses within a reasonable time period.

The employee must return excess allowance within a reasonable period of time.

There are many potential expenses that qualify under Accountable Plans, such as local and out of area business travel, parking, client meeting costs, business meals & entertainment, cell phone/Internet, business tools/supplies and other equipment, home office expenses, auto expenses, training and certifications.

Adequate accounting by the employee involves giving the employer a statement of expenses that documents the business expense along with receipts or other supporting documents. The employee must generally account to the company for the expenses within 60 days after they were paid or incurred.

In order to avoid W-2 inclusion, the employee must generally either account for all monies advanced by the employer in a timely manner or return any funds in excess of documented expenditures within 120 days of the original receipt of funds.

If the employee does not follow the rules above, the expenses are treated as having been reimbursed under a “Non-accountable Plan.” Under a Non-accountable Plan, all advances/allowances and reimbursed expenses are combined with the recipient’s wages, salary and other pay and reported on the employee’s W-2.

Conclusion

There is no requirement to have an Accountable Plans in writing, however, it is a good idea to put it in writing so that the arrangement is fully documented and the employees and employer know exactly what the advances, expenses and documentation procedures are.

Although there are specified recordkeeping requirements associated with Accountable Plans, the benefit to both the employee and the employer can make adoption of these plans very attractive. Employers are able to control costs while giving their employees advanced funds and a reasonable level of control over how the employee spends these budgeted funds for valid business purposes.

Certain financial institutions also have credit card programs whereby groups of employees can only charge specific types of expenses on the card, such as meals, hotels and airlines, but no retail-type items. These programs also generally provide web-based reports for the employer to monitor and account for the employee expenditures.

Accountable Plans will be even more attractive as tax rates increase in 2011.